Working of the Protocol
Stakeholders in the Protocol
Borrowers – Borrows or generate stable coin credit by depositing acceptable volatile assets (Ethereum) as Collateral
Credit Default Swap owners – Deposits stable coin to provide downside protection and volatility hedging to the stablecoin borrowers.
Borrowing of stablecoins
A borrower deposits ETH as collateral, and the protocol mints the equivalent value of stable coin in 80% Loan to Value ratio initially which slowly increases to 100% over time.
Assuming the set of borrowers as Br = {b1, b2, b3, b4…………..bn)
Where bi denotes the i-th borrowing position
Initally the collateral accepted against stablecoin credit is ETH The borrowers will take positions at different points of time at different ETH prices and will borrow stablecoin at initial LTV of 80%.
Thus, the ETH prices associated with this group of borrowers can be represented as:
Er = ( E1, E2, E3,E4…………….En)
Where Ei represents the ETH price for the i-th borrowing position
The collateral amount can be denoted as a multiple of ETH, with Di denoting the collateral deposited by the i-th borrower.
The protocol will track the price of ETH from Oracle feeds both at the time of borrowing to store the USD worth of collateral deposited by the borrower. Every borrower will have its dollar worth collateral amount stored in the smart contract parameters when borrowing. Protocol deposits ETH into the ETH vault and takes a short position on the Delta neutral contract. Protocol mints stable coin equivalent to USD worth of ETH collateral deposited
Total Debt for a particular Vault = Amount borrowed + Borrowing Fees The calculation of borrowing fees on stablecoin is based on the current APR which influences the current cumulative rate or normalized rate for the borrower.
Taking Position in Decentralised Credit Default Swap (dCDS)
Each dCDS holder will deposit the USDa stable coins which they can get from the concentrated Liquidity pools and then deposit the same in the dCDS contract.
The contract will save each dCDS holder position and calculate the normalized amounts of the deposits made as per the cumulative rate of the option fees %age change.
The pooling of the total amount and taking a long position on a Delta neutral contract will be done.
An option seller utilizes the pooled amount in an options contract on behalf of dCDS holders. This way, the dCDS holders will get the option fees from borrowers.
The decision to unlock dCDS holder stablecoins is based on tracking a combination of fixed term and protocol parameters.
dCDS holders acquire USDa stable coins from the market through concentrated liquidity pools, depositing them into the dCDS contract.
The contract records each dCDS holder's position, calculating normalized amounts based on cumulative rate changes in option fees. The total amount is pooled to take a long position on a Delta neutral contract. The protocol then utilizes the pooled amount to act as an option seller on behalf of the dCDS position takers & takes a position in an options contract and receive option fees from stablecoin borrowers.
Delta-Neutral Contract (Downside Protection for Borrowers)
A Delta neutral contract involves taking two opposite positions on the price of Collateral/USD. Assuming ETH as collateral, the Delta neutral contract entails taking opposing positions on the ETH/USD price – a short position by the ETH vault on behalf of the borrowers on ETH/USD and a long position by the protocol on behald of the dCDS holder on ETH/USD. In the event of a decrease in ETH's price, the dCDS holder's short position results in a corresponding increase in USD value for each ETH in the vault. This increment is deducted from the dCDS long position. These positions are synthetic, and no cash settlement occurs with every price change; settlement only happens when a dCDS holder withdraws after a 1-month lock-in. At withdrawal, the final balance is calculated, and if positive, a fraction is deducted and given to the dCDS holder.
Calculation of balances of a long position and short position
Short position (Borrowers)
Calculate the quantity of ETH deposited in the ETH vault
Track the price of ETH at short periodic intervals (1 min or less)
If the Price of the ETH in the current periodic interval is higher/lower than the previous periodic interval, then the total balance of the short position will be deducted
X = (Total number of ETH in ETH Vault * ETH Price change (Between Periodic intervals)
Short Position Balance = Total Short Position Balance – (Total number of ETH in ETH Vault * ETH Price change (Between Periodic intervals)).
Long Position (dCDS Holder)
Calculate the total amount of stablecoin deposited in pool
As the price of collateral (ETH) changes, there is a change in the dCDS pool long position balance
Total Long Position Balance = Long position balance in previous interval + X (Real)
Unlocking dCDS stablecoins is determined by a combination of fixed terms and protocol parameters
The ratio of dCDS Pooled Value/ ETH Vault should be greater than equal to 0.2 for 20% downside protection.
Options Contract
The design of the option contract aims to offer borrowers a means of getting downside protection, achieving high capital efficiency in stablecoins on the collateral deposited and also benefiting from a increase in the ETH price . This is accomplished through the combination of put option and call option at specified strike prices selected by the borrower while taking the stablecoin credit.
The option contract facilitates the transfer of option fees from option buyers (i.e., borrowers) to option sellers (i.e. dCDS holders), thereby allowing dCDS holders to earn a high yield APY on their deposited funds while maintaining a Delta-neutral position for borrowers. Their are 5 variations of strike prices that borrowers can take – 5%, 10%, 15%, 20%, and 25%. It implies that borrowers can buy a call option on ETH price on the above percentage ranges for strike prices. The option price will decrease from a 5% strike price option to a 25% strike price option as per the formulas defined which captures the ETH volatility and protocol level risk parameters to come up with an option pricing
Earlier versions of options contracts based on the ERC20 standard failed to adequately distinguish between principal and interest payments while also accommodating for differing rolling maturities. In the past, holders encountered theta decay as all positions neared maturity simultaneously, leading to a prisoner's dilemma. The duration is measured in seconds utilizing Unix-timestamps, as permitted by Solidity.
We will also be utilising Cumulative rate here to accrue the fees from borrowers to dCDS holders. All the option fees will be treated as a percentage gain and a global cumulative rate function will help accrue these fees across dCDS holders based on their time duration and amount of deposits
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